Bonds

Convertible debt and shareholder incentives
Christian Dorion, Pascal Franois, Gunnar Grass , Alexandre Jeanneret

HEC Montral, Canada
a r t i c l e i n f o a b s t r a c t
Article history:
Received 3 October 2012
Received in revised form 29 October 2013
Accepted 30 October 2013
Available online 9 November 2013
Given equity's convex payoff function, shareholders can transfer wealth from bondholders by
increasing firm risk. We test the existing hypothesis that convertible debt reduces this classical
agency problem of risk-shifting. First, we derive a measure of shareholders' risk incentives
induced by convertible debt using a contingent claims framework. We then document that
when risk-shifting incentives are high, the propensity to issue convertible (rather than
straight) debt increases and the negative stock market reaction following convertible debt
issue announcements is amplified. We further highlight that convertible debt is the only type
of security that affects business risk durably downwards. Our conclusions support the agency
theoretic rationale for convertible debt financing especially for financially distressed firms.
2013 Elsevier B.V. All rights reserved.
JEL classification:
G12
G32
Keywords:
Convertible bonds
Risk-shifting
Agency conflict
Financial distress
Asset volatility
Contingent claims
1. Introduction
Equity provides shareholders with a call option on the underlying firm. Because option values are an increasing function of
risk, shareholders can transfer wealth from bondholders by increasing asset risk, leading to the classical risk-shifting (or asset
substitution) agency conflict between shareholders and bondholders.
An appropriately designed convertible debt issue (Jensen and Meckling, 1976 and Green, 1984) can reduce this agency conflict
because conversion forces existing shareholders to share the firm's upside potential as new shareholders are carved in when
convertible bondholders choose to convert. This mitigates incentives for existing shareholders to engage in asset substitution.
The asset substitution problem has been widely analyzed in theoretical studies on agency conflicts. Yet, De Jong and Van Dijk
(2007) and Graham et al. (2002) conclude from large-scale CFO surveys that managers care little about asset substitution in
practice. This may be attributable to the observation that incentives to engage in asset substitution are most acute when firms are
financially distressed and that most respondents are unlikely to be financially distressed at the time of the survey. In line with this
perspective, Grass (2010) challenges the notion that ex-ante concerns about asset substitution are pervasive. Consistent with his
view, Eisdorfer (2008) notices that broad empirical support for this agency conflict is scarce and provides specific evidence of
risk-shifting in financially distressed firms.
The first objective of this paper is to gauge the economic magnitude of risk-shifting and the potential benefits from issuing
convertible debt. To evaluate the economic significance of risk-shifting incentives, we develop a simple contingent claims
Journal of Corporate Finance 24 (2014) 3856
We thank the editors Craig Lewis and Chris Veld, and an anonymous referee, as well as Tolga Cenesizoglu, Jean-Sbastien Michel, and participants at the
2013 IFM2 Mathematical Finance Days for helpful comments. Franois Leclerc, Manping Li and Siyang Wu provided valuable research assistance. The authors
are also afliated to CIRPEE. Financial support from IFM2 (Dorion, Grass, and Jeanneret) and SSHRC (Franois) is gratefully acknowledged.
Corresponding author.
E-mail address: gunnar.grass@hec.ca (G. Grass).
0929-1199/$ see front matter 2013 Elsevier B.V. All rights reserved.
http://dx.doi.org/10.1016/j.jcorpn.2013.10.008
Contents lists available at ScienceDirect
Journal of Corporate Finance
j our nal homepage: www. el sevi er . com/ l ocat e/ j cor pf i n
framework that quantifies the magnitude of shareholders' incentives to increase risk. We then introduce equity vega as a
measure of the potential economic loss associated with the risk-shifting incentives of shareholders (RSI).
1
We compute RSI for a
broad sample of U.S. firms. On average, shareholders of firms that already have outstanding convertible debt can increase the
value of their equity claim by nearly 2% if they increase asset volatility by 5%. Had those firms not used convertible debt financing,
this increase would have been 2.6%, implying that convertible debt has reduced RSI by 0.6 percentage points across all sample
firms. A closer look at the distribution of issuers reveals that most firms are largely unaffected by asset substitution problems,
indicating that RSI is highly skewed. The incentives are most pronounced for a small number of highly levered issuers that have
high exposure to such incentives. For example, one percent of the firms we consider have equity vegas that exceed 25%. In line
with Eisdorfer (2008), our results suggest that the change in risk-shifting incentives induced by convertible debt is more
economically significant for the subset of firms close to financial distress.
Our second objective is to consider whether risk-shifting incentives are empirically relevant. Our approach is threefold. First,
we conduct an event study to understand how RSI influences the market reaction to convertible debt issuance. We show that
shareholders perceive convertible debt issue more negatively when risk-shifting incentives are stronger. We also explore the
cross-sectional variation in RSI to investigate the determinants of the announcement of convertible debt issuances and find that
issue size, regulated status and CEO ownership are important explanatory variables. Overall, the evidence is consistent with the
observation that convertible debt financing can mitigate agency costs associated with asset substitution. Second, we analyze the
evolution of firm risk around such offerings and compare it to changes in risk around straight debt and equity offerings. We
document both a strong short-term drop and a long-lasting reduction in firm risk around the issuance of convertible debt. Third,
we study the decision to issue convertible debt. Results from a multinomial logit model la Brown et al. (2012) show that firms
with high risk-shifting incentives are more likely to issue convertible debt. The RSI-induced preference for convertible debt is
even stronger when firms are financially distressed. The findings are robust across various controls and sub-samples.
The remainder of this paper is structured as follows. In Section 2, we review the literature on the use of convertible debt
financing. The contingent claims analysis of risk-shifting incentives is conducted in Section 3 along with an empirical estimation
of RSI for a large sample of U.S. firms that have issued convertible debt. Section 4 investigates the announcement effects of
convertible debt issues. The dynamics of business risk around convertible debt issuance is examined in Section 5, and Section 6
studies the effect of RSI on the decision to issue convertible debt. Section 7 concludes. Methodological details are presented in the
Appendices A, B and C.
2. Previous studies
Why do firms issue convertible debt and why do investors buy it? Despite the widespread use of convertible bonds as
financing instruments, these questions remain challenging both theoretically and empirically. In this section, we present a broad
overview of the common theories explaining the existence of convertible debt together with empirical evidence, and continue
with a review of studies related to convertible debt financing and risk-shifting.
2.1. Convertible debt nancing
Early studies suggest that convertible debt can be attractive to young companies due to its relatively low coupon. Brennan and
Schwartz (1988) highlight that convertible debt cannot provide firms with a free lunch because it does not reduce the overall
costs of financing. However, it does decrease the initial interest expense and can thus be advantageous to companies that will
need liquidity in the near future. Along these lines, Mayers (2000) suggests that callable convertible bonds, which allowthe issuer
to force conversion, can be used by companies that have sequential financing needs due to growth options. In case these options
turn out to be valuable in the future, firms can force the conversion of bonds into equity and raise additional financing. If the
growth options do not turn out to be valuable, bonds are not converted, and excessive financing leading to overinvestment is
prevented. Mayers' argument is supported by the observation that especially small companies with high growth rates use
convertible debt for financing, as documented in Lee and Figlewicz (1999). Lyandres and Zhdanov (2014this issue) provide
another investment-based explanation for issuing convertible debt. They show using a theoretical framework that the issuance of
convertibles helps alleviate the underinvestment problem (debt overhang, Myers, 1977).
Stein (1992) argues that firms use convertible debt as backdoor equity financing. Given information asymmetries between
management and investors, equity issues are relatively unattractive. In line with the pecking order theory, a firmtherefore prefers
to issue less risky securities for financing. However, debt financing can be expensive given the high cost of financial distress and
potential risk-shifting problems (see Choi et al. (2010)). Callable convertible bonds allow forced conversion and are attractive for
firms that are optimistic about their future stock price performance. Following a stock price increase, firms can force conversion to
bring equity into their capital structures. Stein (1992) and Mayers (2000) suggest that convertible debt is particularly interesting
for high-growth companies. Jalan and Barone-Adesi (1995) add that even though it is backdoor equity, convertible debt provides
the benefit of interest tax deductibility until conversion, which equity does not. Stein's (1992) argument is supported by empirical
1
Equity vega is dened here as the partial derivative of equity value to an instantaneous change in the volatility of the underlying assets. This interpretation is
somewhat loose, as we consider the sensitivity of equity to discrete changes in volatility. Our main results use a volatility change of 5%.
39 C. Dorion et al. / Journal of Corporate Finance 24 (2014) 3856
evidence that high-quality firms issue debt, medium-quality firms issue convertible debt, and low-quality firms issue equity (see
Lewis et al. (1998)).
Other studies claim that convertible debt financing can be used as a signalling instrument. Nyborg (1995) studies the
signalling effect of the choice of call policy. He argues that the advantages of convertible debt as delayed equity are only
maintained if conversion is voluntary. Nyborg's claim explains the observation that firms, on average, delay forced conversion
until the conversion value reaches a substantial premiumof 43.9% on call prices. Kraus and Brennan (1987) argue that convertible
debt can be used to convey information about firm risk.
Brennan and Schwartz (1988) also use information asymmetries about firm risk to justify the use of convertible debt.
However, Brennan and Schwartz's argument is not based on signalling. Rather, they observe that the value of convertible debt
is less sensitive to changes in the issuer's risk than is straight debt because the value of the convertible's straight debt
(warrant) component decreases (increases) in asset risk. The researchers argue that, given uncertainty about the true asset
volatility, convertible debt is easier to price than straight debt, and investors may therefore be willing to provide funds on
better terms.
2.2. Convertible debt and risk-shifting
Equity payoff is a convex function of firm value. Shareholders can therefore increase the value of their claim by augmenting
firm risk. In doing so, shareholders transfer wealth from the owners of straight debt, whose payoff function is concave. As argued
by Jensen and Meckling (1976) and Green (1984), convertible debt can reduce this classical agency problem of risk-shifting (also
called asset substitution): If equity values are above the strike price of the conversion option (which corresponds to a warrant),
convertible debt investors will exercise the option and convert their bonds to newly issued shares, diluting the wealth of old
shareholders who now must share the firm's upside potential. The introduction of convertible debt thus alters the payoff function
of equity such that the incentives of existing shareholders to shift risk via asset substitution decrease. Green (1984) concludes
that the right convertible design can align the objectives of firm and equity value maximization.
Multiple studies show different limitations of Green's (1984) argument. Using game theoretical analysis, Franois et al. (2011)
show that Green's results do not necessarily extend to a multi-period setting. Frierman and Viswanath (1993) argue that the
effectiveness of convertible debt in reducing the risk-shifting problem is limited if investors can trade derivatives written on firm
assets. According to Chesney and Gibson-Asner (2001) and Grass (2010), the risk-shifting problemis less severe when accounting
for the possibility of default before debt maturity. In contrast, Hennessy and Tserlukevich (2009) argue that shareholders always
benefit from increases in asset risk if the firm is close to default.
Several empirical studies support the relevance of risk-shifting for the choice of convertible debt as a financing instrument.
Lewis et al. (1999) observe that price reactions around convertible debt issues are conditioned on investors' expectation of
whether or not they are used to reduce agency conflicts. The researchers suggest that both asset substitution and information
asymmetries are motives for issuing convertibles. Krishnaswami and Devrim (2008) provide empirical evidence that the agency
cost of debt determines the choice of convertible over straight debt financing. King and Mauer (2014this issue) show that the
call policy for convertible bonds is, in part, designed to reduce agency conflicts between equity and debt.
Additionally, several studies examine the long-term change in different measures of risk around convertible debt issues.
Lewis et al. (2013) report decreases in asset and equity betas and increases in idiosyncratic and total risk for their sample
period 19791990. They conclude that not all issuers use convertible debt financing to reduce agency conflicts. Zeidler et al.
(2012) confirm the decrease in systematic equity risk for the years 19802002 and document that this change is more
pronounced for small firms.
In summary, the discussion about whether convertible debt can and does mitigate risk-shifting is not over. Various theoretical
studies questioning Green's (1984) argument contrast with scarce empirical evidence supporting the general notion that
convertible debt is used to mitigate the agency conflicts of debt financing. We add to the existing literature by isolating the effects
of convertible debt on the value of risk-shifting for a broad dataset using a contingent claims framework. Understanding what
drives these changes in incentives is not obvious. As pointed out by Siddiqi (2009), who uses simulation techniques to derive the
optimal financing mix, agency costs of risk-shifting are very sensitive to the capital structure choice.
Our paper contributes to the literature by measuring risk-shifting incentives and quantifying the economic significance of the
risk-mitigating role of convertible debt.
3. The magnitude of risk-shifting incentives
Risk-shifting incentives can create an agency conflict if the magnitude of such incentives is economically significant. In
this section, we propose a measure of risk-shifting that we first discuss in a numerical analysis and that we then employ in a
comprehensive empirical study.
3.1. Measuring the benets from risk-shifting
The proposed measure is based on the pricing of equity as an option on firm assets. We start by introducing the pricing
framework employed in this study.
We consider that firms are financed with a combination of equity E, straight debt D
S
, and subordinated convertible debt D
C
. All
debt matures at time T, which also corresponds to the time of conversion.
2
The face values of straight and convertible debt are
denoted by F
S
and F
C
, and r is the risk-free rate. All three claims add up to firm value V:
V E D
S
D
C
: 1
This framework allows us to price all three securities using standard pricing formulae for European options. The values of
equity, straight debt and convertible debt as contingent claims are given by:
E C K F
S
F
C
; C K F
S

F
C
;
_ _
; 2
D
S
F
S
e
rT
P K F
S
; ; 3
and
D
C
F
C
e
rT
P K F
S
; P K F
S
F
C
; C K F
S

F
C
;
_ _
; 4
where C(K,) and P(K,) are the values of a European call and put option on firmvalue, calculated as a function of strike price K and
other pricing parameters using the Black and Scholes (1973) and Merton (1974) pricing formulae. Finally, is the conversion
ratio expressed in percentage terms. It is equal to the fraction of total equity owned by the new shareholders and thus measures
the dilution of existing equity induced in case of conversion.
Fig. 1 illustrates how these securities can be viewed as options written on firm assets. In the simple Black and Scholes (1973)
and Merton (1974) framework (upper left graph), shareholders own a call option, while debt holders hold a combination of a
risk-free bond and a short put option on firm value. This is due to their payoff structure: Equity holders have unlimited upside
potential and thus benefit from positive firm developments. At the same time, equity holders have limited liability if the firm
defaults. Debt holders, however, lose a part or all of their investment if the firm defaults, but never get more than the pre-agreed
face value at debt maturity even if firm value increases substantially.
In contrast, the owners of convertible debt (both lower graphs in Fig. 1) participate in the firm's upside potential as their
payoff increases beyond the face value of the convertible if asset values are high enough to make the conversion valuable.
Convertible debt financing affects the payoff and thus the pricing of equity: If the option to convert the bond into equity is in the
money, owners of convertible debt will exercise it. As opposed to the exercise of a plain vanilla call option on a stock, the exercise
of the conversion option corresponds to the exercise of a warrant. This means that old shareholders must share the payoff with
new shareholders as new equity is issued and existing equity is diluted (stock settled convertibles).
The last decade has witnessed a surge in the issuance of cash-settled convertibles. Lewis and Verwijmeren (2014this issue)
show that this trend can be attributed to changes in accounting rules. The cash settlement provision hardly affects the risk
incentive mitigation effect of convertibles, however. Indeed, by selling a conversion option, shareholders commit to sharing the
upside benefits with convertible debt holders. This in turn creates the concavity in shareholders' payoff, which essentially
provides the disincentive for risk-shifting. Admittedly, the cash settlement provision allows shareholders to avoid dilution upon
conversion. Equity holders are thus obliged to share the upside firm value but not voting rights with convertible debt holders.
Compared to cash-settled convertibles, stock-settled convertibles might therefore induce a stronger disincentive for risk-shifting,
as their conversion entails for shareholders a loss in value and control.
In practice, most firms using convertible debt are also partly financed with straight debt. This is important for our study
because we are interested in the agency conflict between shareholders and the owners of straight debt (also referred to as
bondholders). Whenever a firm is financed with both convertible and straight debt, we assume the former to be subordinated.
The lower right graph thus represents the capital structure that is at the center of our study. Shareholders have incentives to
increase firm risk under the simple capital structure (see the upper left graph in Fig. 1). Given their convex payoff, shareholders
benefit fromthe higher upside potential, but do not have to be concerned about the increased downside of risky investments. The
change in the value of their claim following an increase in risk can be computed using the formula that prices equity as a
contingent claim.
We now introduce an intuitive measure of the value of risk-shifting. Based on Eq. (2), we calculate shareholders' risk-shifting
incentives, RSI, as follows:
RSI
E
V
; T;
E
V
; T;
1; 5
where describes an exogenous shift in firm risk. The RSI measure captures by how many percentage points the value of equity
changes given a shift in firm risk. It is thus a direct measure of the value of risk-shifting to shareholders. We examine the classical
2
This assumption is reasonable for any rm with a moderate payout policy, no shocks to rm value dynamics and for which forced conversion can be ruled out
by assuming that the convertible is non-callable. Empirically, Nyborg (1995) observes that even if a convertible is callable, rms tend to signicantly delay the use
of their call option for forcing conversion.
agency conflict arising from the incentive of shareholders to steal wealth from bondholders by risk-shifting. Shareholders will
typically risk-shift by increasing firm risk as long as their payoff is convex in firm value. We thus restrict our analysis to N 0.
3.2. Numerical analysis
Fig. 2 displays RSI and the dollar value of risk-shifting, E(
V
+ , T,) E(
V
,T,), as a function of asset value. Interestingly, the
dollar value gain from risk-shifting admits a maximum for relatively low asset value (see left graph of Fig. 2). Indeed, in the
extreme cases (asset value being very low or very high), the value of equity gets very close to the intrinsic value of the call option
on assets. The speculative value being close to zero, there is not much to gain (in dollars) from risk-shifting. In relative terms
(which is what shareholders care about), the story is quite different. The right graph of Fig. 2 shows indeed that shareholders'
incentive to increase risk is highest for lowfirmvalues, that is, in financial distress, both under straight-debt-only financing (black
line) and a straight debt convertible debt mix.
3
Convertible debt in the capital structure clearly attenuates the risk-shifting
incentive.
Overall, we note that the change in the value of risk-shifting induced by convertible debt can amount to several percentage
points, which clearly is economically significant. Second, convertible debt has the strongest impact on risk-shifting incentives for
firms in financial distress. Firms with little debt are distant from default and, in contrast to shareholders of distressed firms, their
shareholders cannot steal a significant amount of wealth from bondholders by risk-shifting. In line with this finding, Eisdorfer
(2008) documents a tendency of firms in financial distress to take on risky projects even if they generate little or no value.
3.3. Empirical estimation of risk-shifting incentives
In the following subsection, we estimate the effect of convertible debt on shareholders' risk-shifting incentives for a broad
sample of U.S. firms.
3
Given that the face value of debt is xed in Fig. 2, lowrm values correspond to high leverage. For the lowest rm values displayed, rms can be considered in
nancial distress.
Fig. 1. The figure shows payoff (solid lines) and value (dashed lines) of equity (black), straight senior debt (dark gray), straight junior debt (light gray, upper
right) and convertible debt (light gray, lower graphs) as a function of firm value for four different capital structures. The parameters are r = .05,
V
= .4, T = 1,
F
S
= 45 (upper left graph), F
S,sen
= 30, F
S,jun
= 15 (upper right graph), F
C
= 45, = .35 (lower left graph), F
S,sen
= 50, F
C,jun
= 30, and = .35 (lower right
graph).
3.3.1. Data and parameters
Our sample covers the period 1984 to 2010 and consists of all firm-year observations with reported convertible debt financing.
We exclude observations for which the central accounting and stock market variables needed to compute pricing parameters are
not available in the Compustat and CRSP databases.
4
The sample includes 17,867 firm-year observations. Appendix A provides
details on the calculation of the different pricing parameters and variables.
Table 1 displays descriptive statistics for our parameter estimates, which are in line with those documented in the previous
literature. As outlined in Section 2, issuing convertible debt is particularly interesting for young, small, and risky firms with high
growth.
On average, firms with convertible debt are substantially leveraged (with book leverage close to 50%) and have risky
operations (with asset volatility at approximately 47%).
5
However, we note some strong heterogeneity in leverage, business risk,
and conversion ratio.
3.3.2. Results
Table 2 shows empirical estimates for shareholders' risk-shifting incentives for a comprehensive sample of firms that use
convertible debt financing. It also reports how they are affected by convertible debt. We compute the risk-shifting incentives, RSI,
with and without convertible debt. The first rowof each panel shows the increase in shareholder value following a rise in firmrisk
by under the actual capital structure, including convertible debt financing.
Panel (a) of Table 2 indicates that, on average, shareholders can increase the value of their claim by nearly 2% if they increase
asset volatility by 5%. Comparing average and median values indicates that the distribution of RSI is highly skewed. For the
majority of firms, risk-shifting incentives are negligible, and firms are therefore unaffected by the asset substitution problem.
However, a small number of firms exhibit a high exposure to such risk. For the top one percent of firms, a 5% increase in asset
volatility induces a 25% increase in equity value.
Shareholders benefit from increases in firm risk under most capital structures. However, in some scenarios, convertible debt
can encourage shareholders to reduce asset risk in order to lower the likelihood of conversion and thus the dilution of existing
shares. Therefore, RSI can be either positive or negative.
The second row displays statistics for the distribution of RSI computed for hypothetical firms in which convertible debt
financing has been replaced with straight debt financing (that is, the conversion ratio is set to zero). Shareholders will always
benefit fromincreases in firmrisk under this simple financing mix of straight debt and equity. The third rowreports the difference
between the true RSI and the hypothetical RSI (second rowminus first rowvalues) and is positive by construction. For the average
firm, the presence of convertible debt decreases the value of risk-shifting by almost 0.6 percentage points: Without convertible
debt, shareholders could have increased the value of their claim by 2.6% instead of 2% had they increased asset volatility by 5%.
Inspection of panels 2 (a), 2 (b) and 2 (c) shows that RSI and changes in RSI almost linearly increase with . Hence, the RSI metric,
as a sensitivity measure, is largely unaffected by the choice of .
Overall, the results presented in Table 2 are consistent with the hypothesis that the issuance of convertible debt can
substantially reduce the benefits from risk-shifting.
4
Specically, we require the availability of the Compustat items DLTT, DLC, DCVT, SIC, and CSHO, and the CRSP items SHROUT, PRC, and RET.
5
Our estimate of asset risk is higher than that reported in various other studies, in particular because of the covered time period that includes the 2008
nancial crisis. Eisdorfer (2008) reports an average asset volatility of 25% for a comprehensive sample covering the years 1963 to 2002 and thus including early
years during which asset risk was low. Eom et al. (2004) calculates an average asset risk of 23% for a sample of large issuers of corporate bonds. For a more
comparable sample covering the period 19802003, Bharath and Shumway (2008) report clearly higher values. They calculate median volatilities of 46% and 42%
using the iterative measure by Crosbie and Bohn (2003), and their own measure, respectively.
Fig. 2. The figure displays our measure of risk-shifting incentives, RSI, in dollar terms (left graph) and relative terms (right graph). Solid (dashed) lines represent
equity value in a firm financed only with straight debt (with straight and convertible debt). The difference between the two is the reduction in risk-shifting
incentives induced by convertible debt. The parameters are: = .4, = .05, = .35, r = 0.05, and T = 4.
4. Announcement effects of convertible debt issues
The main objective of this paper is to investigate whether convertible debt financing can help alleviate the classical agency
problem between equity holders and bondholders. Convertible debt financing reduces shareholders' incentives to increase risk
and limits their potential to transfer wealth from bondholders. We therefore expect equity prices to decrease and the value of
straight debt to increase upon issuance of convertible debt. Our model further predicts pricing effects to be particularly
pronounced for firms with strong RSI that are in financial distress. We test these predictions by conducting a detailed event study
of 1229 convertible bond offerings on the issuer's equity returns. We also explore the effect on a firm's cost of debt.
4.1. Computation of abnormal equity returns
Our primary dataset includes convertible debt offerings made between 1984 and 2010 that are included in the SDC Platinum
database. Following common methodology, we delete offerings made by financial firms. As discussed later in this paper,
regulation can have an impact on the agency problem of risk-shifting. We therefore also exclude utilities and firms active in the
telecommunications sector which was only deregulated at the end of the last century from our main sample and examine
them in a separate analysis. Furthermore, we follow Duca et al. (2012) and only include standard types of convertible bonds.
Specifically, we exclude mandatory convertibles, exchangeable bonds, and convertible preferred stock. Finally, we delete all
observations from the sample for which we are not able to obtain the necessary data to construct our control variables.
We follow standard event study methodology and use a market model to compute 3-day buy-and-hold abnormal returns
(BHARs). The event window spans one day before to one day after the event.
6
The event date determination strictly follows the
approach of Duca et al. (2012) and is detailed in Appendix B. We define a stock's BHAR as the difference between its return and
6
Consistent with Duca et al. (2012), we include the day following the event in order to capture the reaction to an announcement made after the closing of the
stock markets. Our results are robust to using an event window spanning only two days.
Table 2
Convertible debt and the magnitude of risk-shifting incentives, empirical estimates. This table displays the average and different percentiles of the distribution of
the value of risk-shifting. The sample covers the period 1984 to 2010 and consists of 17,867 firm-year observations with reported convertible debt outstanding. As
detailed in Section 3.1, we compute RSI, a measure of the value of risk-shifting, as the percentage increase in the value of equity following an increase in asset
volatility by . RSI
= 0
is computed for hypothetical firms for which the convertible debt financing is replaced with straight debt financing. By construction, RSI is
lower than RSI
= 0
, given that convertible debt reduces the value of risk-shifting. The difference between the two measures (RSI RSI
= 0
) is thus always
positive. All values are in percent. Panels (a), (b) and (c) contain statistics for a low, medium and high level of risk-shifting, respectively.
Mean Std 1st 25th 50th 75th 99th
(a) = .05
RSI 1.990 5.398 0.840 0.045 0.270 1.730 25.535
RSI
= 0
2.574 5.736 0.000 0.110 0.671 2.498 27.363
RSI RSI
= 0
0.584 0.817 0.000 0.109 0.320 0.731 4.065
(b) =.1
RSI 4.123 11.018 1.430 0.041 0.705 3.693 50.646
RSI
= 0
5.303 11.774 0.000 0.307 1.527 5.238 55.077
RSI RSI
= 0
1.180 1.699 0.000 0.222 0.641 1.463 8.379
(c) = .2
RSI 8.662 22.591 2.118 0.057 2.010 8.127 100.419
RSI
= 0
11.034 24.363 0.000 0.944 3.657 11.128 110.994
RSI RSI
= 0
2.373 3.628 0.002 0.446 1.269 2.904 17.242
Table 1
Descriptive statistics for parameter estimates. This table provides the average, standard deviation, and different percentiles of the distribution of several pricing
parameters (some of which we scale by asset value for this table) employed in this study. All variables are defined in Appendix A. The number of firm-year
observations equals 17,867.
Mean Std 1st 25th 50th 75th 99th
Conversion ratio: 0.117 0.108 0.002 0.041 0.086 0.160 0.526
Proportion of convertible debt: F
CD
/V 0.154 0.199 0.000 0.038 0.097 0.198 0.915
Proportion of straight debt: F
SD
/V 0.319 0.420 0.000 0.039 0.190 0.457 1.795
Proportion of equity debt: E/V 0.676 0.213 0.108 0.541 0.722 0.843 0.982
Asset volatility:
V
0.467 0.319 0.128 0.264 0.384 0.575 1.563
Time to maturity: T 4.801 1.912 0.753 3.451 5.113 5.651 8.850
Risk-free rate: r 0.059 0.024 0.010 0.044 0.058 0.076 0.126
the return predicted by a one-factor market model, where the market index is given by the CRSP value-weighted index.
7
Parameters of the market model are estimated over a window of 255 trading days ending 31 days before the event. Returns must
be available for at least 90 days during the estimation window. In case an event falls on a non-trading date, we change it to the
next trading date.
We observe negative and significant abnormal returns around the announcement of convertible debt offerings. Over the
19842010 period, the average 3-day effect is 3.5% (see Table 3). Both the sign and the magnitude are in line with previous
studies. Dann and Mikkelson (1984) show that shareholders earn significant abnormal returns of 2.31% on the announcement
date of convertible debt offerings. Similarly, Eckbo (1986) reports an average two-day abnormal return relative to the
announcement date that varies between 1.2% and 1.8%, and shows that the effect increases for lower debt ratings. Duca et al.
(2012) show that the 3-day effect varies between 1.7% over the 19841999 period and 4.6% over the period 20002008.
Henderson and Zhao (2014this issue) find a similar two-day announcement effect (4.78%) over the period 20002010.
8
7
Given that we examine short term announcement effects, BHARs are virtually identical to traditional cumulative abnormal returns; the correlation between
the two equals 99.9%.
8
This result holds for convertible issuers that are not conducting concurrent transactions. In their analysis, Henderson and Zhao (2014this issue) show that
the announcement effect varies when convertible issuers conduct concurrent transactions.
Table 3
Descriptive statistics for risk-shifting incentives (RSI), abnormal returns (BHARs) and the control variables. This table provides the average, standard deviation
and different percentiles of the distribution of RSI, BHARs and control variables, together with the number of observations for which the data are available (N).
The upper (lower) panel displays statistics for the subsample of convertible debt (straight debt).
Mean Std 1st 25th 50th 75th 99th N
(a) Convertible debt issues
RSI (%) 0.936 3.170 0.497 0.000 0.010 0.525 15.586 1.229
BHAR 0.035 0.069 0.237 0.071 0.030 0.005 0.150 1.229
CD to total debt 0.192 0.341 0.000 0.000 0.000 0.207 1.000 1.229
Leverage 0.226 0.206 0.000 0.062 0.178 0.336 0.855 1.229
Log MB 0.963 1.030 0.441 0.467 0.826 1.200 6.839 1.229
Stock return volatility 0.574 0.240 0.242 0.398 0.525 0.698 1.364 1.229
Nasdaq listing 0.378 0.485 0.000 0.000 0.000 1.000 1.000 1.229
Firm size 6.962 1.513 3.378 5.998 7.007 7.913 10.997 1.229
Tangibility 0.482 0.373 0.021 0.199 0.377 0.693 1.633 1.229
R&D intensity 0.635 5.090 0.000 0.000 0.006 0.092 10.975 1.229
Amihud liquidity 0.140 0.872 0.000 0.001 0.006 0.034 2.232 1.229
Dividend paying 0.303 0.460 0.000 0.000 0.000 1.000 1.000 1.229
Rule 144a 0.476 0.500 0.000 0.000 0.000 1.000 1.000 1.229
Financial distress 0.000 2.523 2.202 2.065 0.710 0.978 8.769 1.220
Secured debt 0.962 6.728 0.000 0.000 0.179 0.870 5.274 988
Proceeds 0.152 0.107 0.017 0.080 0.128 0.194 0.558 1.229
Debt maturity (years) 4.315 2.039 0.500 2.782 4.186 5.807 8.636 1.229
CEO ownership (%) 2.452 4.875 0.010 0.270 0.759 2.100 26.194 378
SP500 return 0.139 0.185 0.366 0.057 0.154 0.277 0.464 1.229
Interest rate (%) 5.811 2.130 2.746 4.200 5.130 7.243 11.922 1.229
Baa credit spread (%) 2.330 0.692 1.468 1.780 2.190 2.770 5.306 1.229
Leading indicator 81.440 12.714 58.500 67.225 87.700 93.600 93.600 1.229
(b) Straight debt issues
RSI (%) 1.652 3.889 0.249 0.003 0.213 1.532 20.445 4.447
BHAR 0.000 0.040 0.100 0.020 0.001 0.017 0.124 4.447
CD to total debt 0.046 0.138 0.000 0.000 0.000 0.000 0.792 4.447
Leverage 0.346 0.209 0.008 0.179 0.317 0.486 0.890 4.447
Log MB 0.742 0.939 0.799 0.289 0.652 1.020 5.963 4.447
Stock return volatility 0.376 0.163 0.184 0.270 0.330 0.438 0.934 4.447
Nasdaq listing 0.087 0.282 0.000 0.000 0.000 0.000 1.000 4.447
Firm size 8.209 1.607 4.342 7.119 8.263 9.279 12.063 4.447
Tangibility 0.678 0.397 0.023 0.384 0.635 0.947 1.800 4.447
R&D intensity 0.014 0.040 0.000 0.000 0.000 0.015 0.145 4.447
Amihud liquidity 0.115 0.947 0.000 0.000 0.002 0.011 2.128 4.447
Dividend paying 0.694 0.461 0.000 0.000 1.000 1.000 1.000 4.447
Rule 144a 0.287 0.452 0.000 0.000 0.000 1.000 1.000 4.447
Financial distress 0.187 2.414 2.202 2.202 0.906 0.892 8.824 4.411
Secured debt 0.337 3.157 0.000 0.000 0.044 0.326 1.337 3.623
Proceeds 0.155 0.258 0.001 0.027 0.076 0.182 1.218 4.447
Debt maturity (years) 5.185 2.014 0.822 3.675 5.317 6.725 8.913 4.447
CEO ownership (%) 3.607 6.614 0.007 0.287 1.000 3.417 33.669 895
SP500 return 0.139 0.186 0.385 0.056 0.153 0.276 0.487 4.447
Interest rate (%) 6.284 1.986 2.739 4.800 6.040 7.458 12.390 4.447
Baa credit spread (%) 2.216 0.735 1.380 1.690 2.060 2.560 5.560 4.447
Leading indicator 79.290 11.934 57.900 67.300 82.000 90.400 93.600 4.447
Fig. 3 displays the average announcement effect on BHARs by quintiles of RSI. Consistent with our prediction, the market
reaction to convertible debt issues appears more pronounced when the level of risk-shifting is high (top-left panel). In contrast,
the emission of straight debt does not seem to affect shareholder wealth, regardless of the level of RSI (top-right panel).
4.2. Regression analysis of announcement effects
We now conduct a cross-sectional analysis of the relation between the stock price effects around the issuance date and the
characteristics of both the issuer and the issued security. In line with De Jong et al. (2011) and Duca et al. (2012), we run a
regression of abnormal returns (BHAR) on a set of variables of interest. In particular, we focus on the firm's level of RSI as
presented in subsection 3.1 and explained in detail in Appendix A.
4.2.1. Control variables
Our set of control variables is similar to that used in Brown et al. (2012). Because the authors document significant differences
between firms that issue convertible debt privately versus publicly, we include a dummy that equals one for all Rule 144a
placements. Our baseline specification includes issuer-specific and market-wide variables.
As far as issuer-specific controls are concerned, we include the logarithm of the market-to-book ratio, a dummy for whether
the issuer's stock is listed on Nasdaq, firm size as measured by the logarithm of the issuer's total assets, the fraction of property
plant and equipment over total assets (referred to as asset tangibility), the ratio of research and development expenses over sales
(referred to as R&D intensity), the Amihud (2002) measure for equity liquidity, and a dummy for dividend-paying firms.
Market-wide variables include the one-year stock market return computed on the S&P500, the 10-year Treasury rate, the
average spread of Moody's Baa corporate bonds over the 10-year Treasury rate, and the Conference Board's Leading Economic
Indicator. Appendix C provides a detailed definition of each of the control variables.
Table 3 reports descriptive statistics for control variables for firms issuing convertible debt or straight debt. The two groups of
firms exhibit different characteristics. Compared to firms issuing straight debt, firms issuing convertible debt have a profile that is
more in line with a younger firm: They are smaller, have less leverage, less tangible assets, more growth opportunities, more
volatile equity returns, and are more likely to be listed on the Nasdaq.
Fig. 3. This figure displays the average announcement effect of security issuances on three-day buy-and-hold abnormal returns (BHARs) and yields spread
changes in the upper and lower panels, respectively. Results on convertible debt issues (left panels) are compared with those for straight debt issues (right
panels). The average effects are reported by quintiles of risk-shifting incentives (RSI).
4.2.2. Effect of risk-shifting incentives
We now test whether the reaction of stock prices to convertible debt announcements can be attributed to variations in
shareholders' risk-shifting incentives. Table 4 reports the results of different regression specifications with BHARs over the
window (1,+1) relative to convertible debt issuances as the dependent variable.
Column (1) shows that RSI enters significantly and negatively, suggesting that a convertible debt issue is perceived more
negatively by shareholders when risk-shifting incentives are stronger. The interpretation of a coefficient of 28.41 is as follows. A
one standard deviation increase in RSI (equal to 0.0317) decreases BHARs from its average of 3.5% to 4.4%. The marginal
change is 0.9% (i.e. 0.0317 28.41), which is economically sizable. The effect of RSI remains large and significant when
excluding market-wide variables (see Column (2)), as well as when including issue-specific variables (see Column (3)).
9
4.2.3. Analysis by distress level
The issuance of convertible debt limits the possibility for shareholders to steal wealth from bondholders. Equity returns to
convertible debt announcements should be more negative for firms with significant credit risk, as the benefits from risk-shifting
are highest for these companies. We test the hypothesis that convertible debt can mitigate agency conflicts in financially
distressed firms by conditioning the announcement effects on the credit risk level. Our measure of credit risk is based on the study
of Campbell et al. (2008) and explained in Appendix C.
The baseline regression is run on subsamples broken down by credit risk levels: above and below the median (Columns (4)
and (5)) or top and bottom quartiles (Columns (6) and (7)). In line with our prediction, we observe that equity values are
Table 4
Risk-shifting incentives (RSI) and the announcement effect of convertible debt issues main results. Displayed are results of linear regressions of abnormal
returns on RSI and control variables. Column 1 reports the baseline model. In Column 2, we exclude the macroeconomic controls used in Brown et al. (2012),
whereas Column 3 additionally considers a set of issue-specific controls suggested by Duca et al. (2012). Coefficients are not reported, but are available upon
request. Columns 4 and 5 report results when firm credit risk is above and below the median, respectively, while Columns 6 and 7 present results related to the
highest and lowest quartiles. All control variables are defined in Appendix C. We report t-statistics, using Huber-White heteroskedasticity-robust standard errors
adjusted for firm-level clustering, in parentheses below the coefficient estimates. t-statistics for the difference in coefficients between subsamples are reported in
square brackets. Significance at the 10%, 5%, and 1% level is indicated by

,

, and

, respectively.
(1) (2) (3) (4) (5) (6) (7)
Financial distress
High Low Very high Very low
RSI (%) 28.41
(3.36)
39.35
(4.55)
23.44
(2.41)
29.94
(3.23)
0.60
(0.04)
[1.68
]
34.73
(2.82)
29.00
(0.36)
[0.79]
Log MB 0.18
(0.97)
0.02
(0.08)
0.14
(0.68)
0.14
(0.65)
0.03
(0.05)
0.24
(0.91)
0.85
(1.01)
Nasdaq listing 0.27
(0.63)
0.65
(1.45)
0.09
(0.20)
0.40
(0.61)
0.99
(1.76)
0.53
(0.52)
1.10
(1.50)
Firm size 1.07
(6.24)
0.54
(3.52)
1.01
(5.71)
1.30
(4.30)
0.75
(3.73)
1.36
(2.68)
0.73
(2.74)
Tangibility 0.52
(1.06)
0.61
(1.22)
1.03
(1.22)
0.50
(0.62)
0.23
(0.33)
0.28
(0.22)
0.40
(0.41)
R&D intensity 0.17
(0.94)
0.29
(1.53)
0.06
(0.34)
0.07
(0.33)
0.40
(1.53)
0.05
(0.19)
0.56
(3.74)
Amihud liquidity 1.50
(2.28)
1.59
(2.18)
1.19
(1.75)
1.34
(1.55)
2.05
(2.31)
1.13
(1.04)
1.66
(1.35)
Dividend paying 0.06
(0.15)
0.62
(1.49)
0.08
(0.19)
0.43
(0.62)
0.39
(0.73)
0.58
(0.43)
0.53
(0.70)
Rule 144a 0.51
(0.96)
2.18
(4.95)
0.44
(0.74)
0.87
(1.10)
0.32
(0.44)
1.18
(0.89)
0.78
(0.75)
SP500 return 4.36
(3.36)
1.90
(1.23)
3.78
(1.85)
4.72
(2.88)
4.84
(1.29)
3.97
(1.87)
Interested rate 0.19
(0.99)
0.06
(0.27)
0.62
(1.91)
0.23
(0.99)
0.94
(1.62)
0.38
(1.20)
Baa credit spread 0.92
(1.75)
0.23
(0.37)
0.53
(0.69)
1.66
(2.42)
0.01
(0.01)
2.59
(2.55)
Leading indicator 0.08
(2.65)
0.02
(0.59)
0.06
(1.37)
0.10
(2.73)
0.01
(0.11)
0.13
(2.31)
Constant 3.07
(0.70)
5.59
(5.06)
5.96
(1.03)
9.27
(1.34)
5.10
(0.92)
16.97
(1.40)
9.84
(1.21)
Issue controls No No Yes No No No No
Observations 1.229 1.229 1.191 610 610 305 305
Adjusted R
2
(%) 11.2 6.0 12.6 9.9 10.6 6.4 12.2
9
The issue-specic variables considered are from Duca et al. (2012). They consist of dummies indicating whether the convertible bond is non-callable, whether
it is the rst time the rm issues convertible debt, whether the issue date equals the announcement date used in the event study, and two time dummies
indicating whether the issue was announced between 1/1/2000 and 14/9/2008 or between 15/9/2008 and 31/12/2009.
particularly sensitive to the level of RSI when firms are in financial distress. RSI coefficients obtained from regressions fitted on
subsamples of high versus low credit risk issuers are substantially different in terms of their magnitude. The difference, however,
can hardly be pinned down statistically. Given that the average RSI of low credit risk firms is extremely small, the RSI coefficients
for the low credit risk subsamples thus have high standard errors. Accordingly, we only observe a weak statistical significance of
the difference for the split along the median, but not along quartiles.
4.2.4. Cross-sectional variations in the effect of RSI
We now explore cross-sectional variations in the effect of RSI to better understand which firms are more affected by the
announcement of convertible debt issuance through RSI. For each variable of interest, we break down the sample according to the
median, and run the baseline regression on the two subsamples. Table 5 reports the results.
The negative market reaction following convertible debt issuance is consistent with the correction of an agency conflict
between shareholders and creditors. All else equal, the greater the size of the convertible debt issue, the stronger the mitigation of
the agency conflict. In line with this intuition, we find that large issue size is associated with a strong contribution of RSI to the
negative market reaction (see the RSI coefficients in Columns (1) and (2)).
When debt is secured, we expect the agency conflict to be mitigated, implying that RSI should play a smaller role in explaining
the BHARs. Similarly, short-term debt is commonly viewed as a disciplining financing tool that reduces the magnitude of agency
conflicts. Along this line, the effect of RSI should be weaker when debt maturity is short. The data indicates, however, that the
effect of RSI is similar across debt maturity and whether debt is secured or not (the RSI coefficients have comparable magnitude
and significance in Columns (3) and (4) as well as Columns (5) and (6) in Table 5).
Regulated firms may not have shareholder value maximization as their only objective. Consequently, these firms are less
concerned with the asset substitution problem, and we expect the market reaction to convertible debt issuance to be little
Table 5
Risk-shifting incentives (RSI) and the announcement effect of convertible debt issues cross-sectional variation. Displayed are results of linear regressions of
abnormal returns on RSI and control variables. Columns 1 and 2 provide results when the issue size is small or large, as separated by the median. Columns 3 and 4
report results when the fraction of secured debt over total debt is below and above the median, respectively, while Columns 5 and 6 present the results when the
average debt maturity is below and above the median, respectively. Columns 7 and 8 compare the results for unregulated and regulated firms. Finally, Columns 9
and 10 display results when the fraction of CEO shares is below and above the median, respectively. All variables are defined in the Appendices A, B and C. We use
Huber-White heteroskedasticity-robust standard errors adjusted for firm-level clustering to compute t-statistics, which are reported in parentheses. t-statistics
for the difference in coefficients between subsamples are reported in square brackets.

,

, and

indicate significance at the 10%, 5%, and 1% level.
(1) (2) (3) (4) (5) (6) (7) (8) (9) (10)
Proceeds % secured debt Debt maturity Regulation CEO ownership
Low High Low High Low High No Yes Low High
RSI (%) 30.28
(3.51)
155.47
(1.98)
[1.61]
44.81
(1.82)
31.54
(2.68)
[0.49]
32.42
(2.25)
24.48
(2.40)
[0.46]
28.41
(3.36)
10.25
(0.85)
[1.30]
67.08
(3.70)
22.15
(1.72)
[2.12
]
Log MB 0.16
(0.79)
0.59
(1.14)
0.22
(0.61)
0.10
(0.40)
0.08
(0.24)
0.33
(1.35)
0.18
(0.97)
0.23
(0.49)
0.59
(1.03)
0.30
(0.81)
Nasdaq listing 1.31
(2.05)
0.74
(1.25)
0.42
(0.58)
0.08
(0.12)
0.81
(1.31)
0.37
(0.64)
0.27
(0.63)
0.34
(0.32)
0.08
(0.06)
2.23
(2.18)
Firm size 1.26
(4.71)
0.79
(3.05)
0.90
(3.37)
1.14
(3.78)
1.20
(4.64)
0.93
(4.31)
1.07
(6.24)
0.84
(1.83)
2.33
(3.88)
0.94
(1.85)
Tangibility 0.85
(1.28)
0.18
(0.23)
0.21
(0.27)
1.25
(1.58)
0.46
(0.55)
0.48
(0.83)
0.52
(1.06)
0.11
(0.09)
0.46
(0.25)
0.75
(0.47)
R&D intensity 0.25
(1.02)
0.00
(0.00)
0.46
(2.27)
0.54*
(1.67)
0.26
(1.16)
0.01
(0.03)
0.17
(0.94)
4.80
(5.77)
0.35
(1.08)
(0.47)
(3.93)
(4.21)
0.03
(0.02)
1.20
(0.98)
1.16
(1.25)
1.05
(1.04)
1.97
(2.76)
1.50
(2.28)
2.39
(1.22)
16.41
(0.41)
18.31
(1.18)
(1.28)
0.61
(0.93)
0.23
(0.33)
0.37
(0.55)
0.11
(0.16)
0.01
(0.01)
0.06
(0.15)
0.10
(0.06)
1.13
(0.83)
0.84
(0.74)
Rule 144a 0.21
(0.28)
1.11
(1.26)
0.87
(1.07)
0.47
(0.55)
1.34
(1.66)
0.44
(0.61)
0.51
(0.96)
3.99
(2.73)
1.18
(1.01)
0.63
(0.53)
SP500 return 1.31
(0.70)
6.99
(3.62)
2.68
(1.24)
5.36
(2.57)
4.30
(2.17)
4.68
***
(2.88)
4.36
(3.36)
3.16
(0.66)
3.16
(0.71)
4.81
(1.20)
Interest rate 0.08
(0.31)
0.42
(1.43)
0.22
(0.72)
0.11
(0.35)
0.47
(1.56)
0.11
(0.48)
0.19
(0.99)
0.29
(0.55)
0.94
(1.15)
0.98
(1.12)
(1.98)
0.09
(0.10)
1.12
(1.27)
1.06
(1.26)
0.25
(0.29)
1.51
(2.51)
0.92*
(1.75)
0.73
(0.64)
1.57
(0.84)
0.42
(0.20)
(2.49)
0.04
(0.87)
0.04
(0.90)
0.15
(2.97)
0.04
(0.80)
0.12
(3.28)
0.08
(2.65)
0.02
(0.30)
0.08
(0.75)
0.06
(0.69)
Constant 0.16
(0.03)
7.75
(1.13)
4.28
(0.61)
2.69
(0.36)
10.04
(1.44)
3.96
(0.75)
3.07
(0.70)
12.26
(1.31)
7.77
(0.44)
22.53
(1.36)
Observations 576 577 491 492 614 615 1.229 104 189 189
Adjusted R
2
(%) 14.1 9.9 9.2 14.9 8.9 13.7 11.2 9.43 12.7 12.8
affected by RSI in regulated industries. Our regression results indicate that the effect of RSI becomes indeed insignificant when it
comes to regulated firms.
10
The CEO's decision to issue convertible debt can weakly or strongly reduce the shareholderbondholder agency problem,
depending on the alignment of his interests with those of shareholders, as measured by the CEO's equity share. We therefore
expect the negative market reaction to exhibit a stronger dependence on the level of RSI when the CEO has a low equity share.
This is indeed what we observe in the data (see Columns (9) and (10)).
4.3. Changes in yield spreads
To further examine the extent to which convertible debt issues help attenuate the agency problem between shareholders and
bondholders, we now analyze the effect of such announcements on the value of straight debt. In particular, we examine changes
in yield spreads on straight bonds issued by firms previous to their announcement of a convertible bond offer. Our sample
includes 68 announcements occurring in such a setting. The number of events for which all required data is available is small, as
explained in detail in Appendix B. Nonetheless, estimating the announcement effects of convertible debt issues on the change in
average yield spread is useful.
On average, yield spreads decrease by 0.60% following the announcement of convertible debt. The reduction in the costs of
debt is both statistically and economically significant. As argued previously, the agency conflict between shareholders and
bondholders should be particularly pronounced for firms close to financial distress. If convertible debt can indeed reduce
shareholder incentives to shift risk, bondholders should benefit most from convertible debt if the issuing firm has a high level of
RSI.
Fig. 3 displays average announcement effects on firm yield spreads by quintiles of RSI (lower-left panel). Consistent with the
analysis of equity returns, the market reaction captured by the change in yield spreads is highest for firms whose shareholders
have the strongest incentives to shift risk.
11
In contrast, no clear pattern emerges when we focus on straight debt issues (right
panels).
In sum, convertible debt issues are bad news for equity holders and good news for creditors, especially when the agency
conflict between shareholders and bondholders is severe, as indicated by a high RSI. Fig. 3 shows this wealth transfer from
bondholders to shareholders. It is consistent with the view that convertible debt reduces the benefits of risk-shifting to
shareholders, decreasing their expected cash flows and increasing those to bondholders.
5. Impact on real investment decisions
Another way to examine the risk-mitigating effect of convertible debt is to investigate the level of investment in risky projects
following the issuance of such security. To this end, we study the dynamics of firm volatility before and after convertible debt is
emitted. We examine the asset volatility that is inverted from equity price dynamics using the Bharath and Shumway (2008)
methodology.
12
Fig. 4 illustrates a clear decline in asset volatility after the issuance of convertible debt. We observe a strong drop in the short
run and a long-lasting reduction. Table 6 reports a decrease of 4.87 percentage points (4.62 percentage points) in asset volatility
three months (two years) following the issuance of convertible debt. In contrast, the issuance of other types of securities (equity
or straight debt) induces a weaker, short-termdecrease in asset volatility that vanishes after a few months. Table 6 reports a drop
in asset volatility induced by equity or straight debt that is substantially lower in magnitude than the one induced by convertible
debt. Convertible debt therefore appears to be the only type of security that affects business risk durably downwards.
6. Risk-shifting incentives and the decision to issue convertible debt
So far, we have examined the consequences of issuing convertible debt. However, risk-shifting incentives should also influence
the decision to issue convertible debt (as opposed to straight debt) in the first place. The aim of this section is to analyze whether
firms with higher RSI are more prone to issue convertible debt rather than straight debt. We also explore how this effect varies
with firm characteristics.
We follow the approach of Hovakimian et al. (2001) and Brown et al. (2012) and employ a multinomial logit model to predict
the issuance of convertible debt. As shown in these studies, controlling for the possibility of issuing equity is important when
examining the choice between straight and convertible debt.
Table 7 reports the results of a multinomial logit regression for which the dependent variable is zero for straight debt issues
(base case), one for convertible debt issuance and two for equity issuance. As our analysis focuses on the decision to issue straight
or convertible debt, we only report results for this alternative. Results for the equity issuance decision are available upon request.
The baseline model is the same as in Section 4. We add two variables to control for the firm's capital structure prevailing a quarter
10
The subsample of regulated rms in Column (8) in Table 5 is dened based on rms' SIC code, as detailed in Appendix C.
11
The increase in the value of straight debt is signicant for the upper four RSI quintiles. This can be explained by the fact that the average RSI is very high for the
subsample of 68 rms issuing convertible debt, which already have straight bonds outstanding as of the announcement date.
12
Alternatively, we computed asset volatility using the iterative method described by Crosbie and Bohn (2003). Results are robust to this choice and available
upon request.
before the announcement of new debt issue, firm leverage and the ratio of convertible debt to total debt. As indicated by the
positive and strongly significant RSI coefficients, firms with higher risk-shifting incentives prefer to issue convertible debt. This
result holds with and without market-wide controls (see Columns (1) and (2)).
When choosing their financing sources, firms may be limited to using one type of debt or another. This raises a concern if the
dependent variable reflects a choice between convertible and straight debt financing. To address this issue, we run the regression
on a restricted sample of firms that already had convertible debt in their capital structures before the new issue. For these firms,
we find that the effect of RSI remains significant and at least as strong as in the baseline case.
We finally explore how the level of credit risk affects the preference for convertibles induced by RSI. As in Section 4, the baseline
regressionis runonsubsamples brokendownby credit risk levels. Whensplitting the sample of observations along the medianfinancial
distress metric (see Columns (4) and (5)), the influence of RSI on the choice of the type of debt is largely unaffected by credit risk. It
nevertheless appears stronger for distressed firms when splitting the sample into quartiles (see Columns (6) and (7)). The same finding
also holds for the subset of firms that already have convertible debt outstanding (see Columns (8) and (9)).
Fig. 4. This figure illustrates the risk-mitigating effect of convertible debt issues on a firm's level of business risk. The analysis focuses on asset volatility, as
inverted from equity price dynamics using the Bharath and Shumway (2008) methodology, around a (24,+24)-month window. The upper panel displays the
dynamics of asset volatility before and after the issuance of convertible debt. Results are compared with the issuance of straight debt (middle panel) and equity
(lower panel). The dashed lines represent 2 standard errors band.
Table 6
The effect of issuing convertible debt on asset volatility. This table reports differences in the average asset volatility before and after issuing convertible debt,
straight debt, and equity. The difference in impact between issuing convertible debt and other securities is investigated using a difference-in-difference approach.
The asset volatility is inverted from equity price dynamics using the Bharath and Shumway (2008) methodology. It is based on returns over a quarter, e.g. the
asset volatility one month before issuance (1) is inferred from returns observed from 4 to 1. Significance at the 10%, 5%, and 1% level is indicated by

,

,
and

, respectively.
Months relative to issue date Difference in mean Difference in difference
CD SD EQ CD-SD CD-EQ
(1, +3) 4.87
(5.66)
1.87
(7.22)
0.74
(1.27)
3.00
(4.48)
4.13
(3.52)
(1, +6) 3.39

(3.93)
1.22
(4.50)
0.71
(1.24)
2.18
(3.18)
4.11
(3.55)
(1, +12) 3.47

(4.03)
0.43
(1.52)
0.89
(1.50)
3.04
(4.34)
4.35
(3.68)
(1, +24) 4.62

(5.18)
0.86
(3.01)
0.14
(0.23)
3.76
(5.22)
4.48
(3.61)
Table 7
Effect of firm risk-shifting incentives (RSI) on the decision to issue convertible debt. Displayed are results of a multinomial logit regression. The dependent
variable is zero for straight debt issues (base case), one for convertible debt and two for equity. Only coefficients for the choice between issuing convertible versus
straight debt are reported. Column 1 reports the baseline model, Column 2 excludes market-wide controls whereas Column 3 restricts the sample to firms already
using convertible debt before the issue. Columns 4 and 5 report results when firm credit risk is above and below the median while Columns 6 and 7 present
results related to the highest and lowest quartiles. Columns 8 and 9 report results when credit risk is above and below the median but only for firms already
financed by convertible debt. All variables are defined in the Appendices A, B and C. We use Huber-White heteroskedasticity-robust standard errors adjusted for
firm-level clustering to compute t-statistics, which are reported in parentheses. t-statistics for the difference in coefficients between subsamples are reported in
square brackets.

,

and

indicate significance at the 10%,5% and 1% level.
(1) (2) (3) (4) (5) (6) (7) (8) (9)
Seasoned Financial distress Seasoned CD
CD High Low Very high Very low High Low
RSI (%) 7.80
(2.92)
9.15
(3.52)
10.12
(3.02)
5.48
(1.83)
12.23
(1.38)
[0.70]
7.29
(2.11)
14.07
(1.02)
[1.48]
6.84
(1.83)
5.49
(0.64)
[0.14]
CD to total debt 1.81
(10.32)
1.78
(10.26)
1.86
(6.62)
1.68
(6.05)
1.85
(7.82)
1.86
(4.76)
1.91
(5.79)
1.93
(4.03)
1.72
(4.83)
Leverage 3.13
(9.87)
3.26
(10.28)
2.49
(4.29)
2.61
(5.85)
2.03
(3.33)
3.04
(4.77)
1.30
(1.32)
1.84
(2.14)
1.59
(1.60)
Log MB 0.02
(0.30)
0.01
(0.13)
0.11
(1.21)
0.05
(0.83)
0.48
(2.90)
0.07
(1.17)
0.55
(2.16)
0.10
(1.29)
0.43
(1.31)
Stock return volatility 1.97
(6.89)
2.08
(7.24)
1.23
(2.31)
1.68
(5.03)
2.91
(5.58)
1.42
(3.34)
4.42
(6.53)
0.39
(0.61)
2.42
(2.23)
Nasdaq listing 0.38
(3.03)
0.39
(3.04)
0.58
(2.84)
0.40
(2.55)
0.35
(1.81)
0.35
(1.66)
0.18
(0.70)
0.99
(3.21)
0.20
(0.56)
Firm size 0.49
(12.85)
0.48
(13.09)
0.42
(5.64)
0.22
(3.87)
0.78
(13.30)
0.14
(1.88)
0.74
(9.53)
0.02
(0.18)
0.82
(7.12)
Tangibility 0.59
(4.94)
0.64
(5.38)
0.12
(0.61)
0.47
(3.23)
0.70
(3.84)
0.36
(1.87)
0.55
(2.00)
0.01
(0.03)
0.21
(0.62)
R&D intensity 4.23
(3.25)
3.57
(3.06)
2.34
(1.05)
5.45
(2.13)
5.61
(4.36)
4.68
(1.39)
3.56
(2.41)
2.20
(0.73)
8.64
(3.94)
(3.76)
0.34
(4.03)
1.03
(1.93)
0.13
(1.72)
0.66
(2.35)
0.03
(0.41)
0.14
(0.70)
0.35
(0.96)
1.58_
(1.83)
(3.30)
0.34
(3.20)
0.49
(2.47)
0.31
(1.97)
0.33
(2.16)
0.23
(0.99)
0.55
(2.43)
0.62
(2.15)
0.63
(1.97)
Rule 144a 0.01
(0.05)
0.04
(0.43)
0.07
(0.33)
0.33
(2.31)
0.45
(2.37)
0.72
(3.42)
0.87
(2.91)
0.08
(0.34)
0.29
(0.81)
SP500 return 0.71
(2.81)
1.11
(2.38)
1.15
(3.07)
0.83
(2.24)
0.70
(1.33)
1.36
(2.46)
1.58
(2.25)
1.62
(2.21)
Interest rate 0.09
(2.25)
0.07
(0.94)
0.10
(1.60)
0.23
(4.01)
0.09
(1.03)
0.20
(2.52)
0.21
(1.68)
0.24
(2.14)
(7.25)
0.56
(3.93)
0.49
(4.26)
0.65
(5.43)
0.54*
(3.70)
0.60
(3.53)
0.51
(2.34)
0.48
(2.02)
(2.00)
0.02
(1.54)
0.01
(0.78)
0.02
(2.68)
0.01
(0.55)
0.03
(2.07)
0.01
(0.90)
0.04
(2.28)
Constant 0.39
(0.47)
2.49
(7.59)
1.39
(0.91)
0.31
(0.25)
1.08
(0.85)
1.31
(0.80)
2.05
(1.15)
0.01
(0.00)
1.84
(0.71)
Observations 9.843 9.843 2.204 4.886 4.887 2.443 2.443 1.085 1.085
LR X
2
43.706 88.117 6.140 27.004 52.988 11.513 25.325 4.183 10.611
Pseudo R
2
(%) 42.2 39.7 39.2 41.5 45.9 45.7 48.2 41.5 42.6
7. Conclusion
As equity resembles a call option on firm assets, shareholders can steal wealth from bondholders by increasing asset volatility.
This article examines whether convertible debt can reduce this classical agency problem of risk-shifting. The following four
results support this hypothesis.
First, we show that both the magnitude of the agency conflict and its mitigation through convertible debt can be economically
significant. To show this, we propose a simple measure of shareholders' risk-shifting incentives, RSI. It is calculated as the percentage
change in the option value of equity due to an increase in asset volatility. We estimate RSI for a comprehensive data set of firms using
convertible debt financing. Even though risk-shifting incentives are lowfor the majority of companies, a small number of firms exhibit a
high exposure to the risk-shifting problem: For the top one percent of firms, a 5% increase in asset volatility induces a 25% increase in
equity value. In the upper percentile, convertible debt reduces the benefits of risk-shifting by more than 4%. Second, we examine the
announcement effects of convertible debt issues on the value of equity and straight debt and document a wealth transfer from
shareholders to bondholders, which is particularly pronounced for firms with high RSI. Share prices drop by 3.5%, while the cost of debt
decreases by 0.6% around the announcement of convertible issues. This wealth transfer is consistent with our main hypothesis: if
convertible debt reduces the benefits of risk-shifting for shareholders, it decreases their expected cash-flows and increases those of
bondholders. We do not observe a wealthtransfer aroundthe announcement of straight debt offerings. Third, we document that the level
of investment in risky projects as proxied for by asset volatility decreases following the issuance of convertible debt. The drop in
volatility is substantially lower around equity and straight debt offerings.
Finally, an ex-ante analysis of the decision to issue convertible debt shows that firms with higher risk-shifting incentives
prefer using convertible debt over straight debt.
Our findings suggest that even though risk-shifting is not a concern in most companies, it affects claimvalues, financing choice
and operational decisions for a subset of firms, particularly those close to financial distress. Convertible debt appears to be one
way of mitigating this agency conflict.
Appendix A. Calculation of RSI
We define the strike prices of convertible debt and equity based on reported face values, in line with Eom et al. (2004) and
Bharath and Shumway (2008). Specifically, we set the strike price of equity and the strike price of the junior convertible debt
equal to the face value of total debt, which we compute as the sum of reported long term debt and debt in current liabilities. We
substract the face value of convertible debt to obtain the face value of the straight senior debt.
As illustrated in Kraus and Brennan (1987), the strike price of the conversion option embedded in the convertible bond can be
computed based on the face value of debt and the dilution measure. Here, the dilution parameter, , equals the percentage of shares,
which would be held by convertible bondholders in case they exercise their conversion option and become new shareholders:

N
New
N
Old
N
New
; A:1
where N
New
is the number of new shares issued in case of conversion and N
Old
is the number of shares outstanding before
conversion. Up to 1996, this ratio can be computed based on the data items common shares outstanding (CSHO) and common
shares reserved for conversion from convertible debt (CSHRC). In 1996, Compustat discontinued the reporting of CSHRC. For the
subsequent firm-years, we account for the historical relation between CSHRC and CSHO, which is given by:
CSHRC 0:8780 0:3309
F
C
E
_ _
ws
CSHO; A:2
where the values 0.8780 and 0.3309 are the coefficient estimates a and b from the pooled linear regression
CSHRC
i;y
a b
F
C; i;y
E
i;y
_ _
ws
CSHO
i;y
: A:3
The regression is fitted using all available data fromthe first part of the sample period. Subscript ws indicates that the ratio F
C
/E
is winsorized at the 99th percentile.
13
The intuition underlying this estimation of CSHRC which corresponds to N
New
is as
follows: N
New
is defined as the number of new shares issued after conversion, and it is equals to the face value of convertible debt
divided by the conversion price. Our estimation implicitly assumes the conversion price to be equal to the current share price
times a factor (1 + p). Then, N
New

FC
E
N
Old
1p
, which we can estimate using the regression described by Eq. (A.3). This procedure is not
only intuitively appealing, but also yields a high fit to the data. The adjusted R
2
of this regression equals 32.97%.
14
13
This means that we set all values in the upper one percent of the distribution of F
C
/E equal to the 99th percentile. Doing so allows us to reduce the number of
outliers that are likely a result of erroneous data.
14
Still, to some extent the estimation procedure remains arbitrary. It is therefore important to note that the risk-shifting measures computed based on this
parameter are similar to those computed for the subsample for which CSHRC is given, and the one for which we must estimate it. The distribution of is
comparable for both subsamples, also. The averages of calculated based on estimated and actual values of CSHRC equal 11.6% and 11.8%, respectively.
Next, we calculate firm risk
V
following the approach of (Bharath and Shumway, 2008), as follows:
V

D
V

D

E
V

E
; A:4
where D = F
C
+ F
D
and the volatility of debt equals
D
:05 :25
E
; A:5
with an equity volatility
E
computed as the annualized standard deviation of daily stock returns observed over the 252 trading
days preceding the fiscal year-end date. While Bharath and Shumway (2008) call their measure naive, they show that it is
highly correlated to the estimates of firm risk by Moody's KMV and that, in combination with other parameters, it is a better
predictor of default risk than alternative, common measures.
We then derive the time to debt maturity, T, as a face value-weighted average of debt with different maturities as follows.
Using the Compustat items long-term debt due in year 1 to 5 (DD
1
through DD
5
), we first estimate the time to maturity of
long-term debt as
T
LT

0:5DD
1
1:5DD
2
2:5DD
3
3:5DD
4
4:5DD
5
D
LT
10 1
DD
1to5
D
LT
_ _
: A:6
As reported by Barclay and Smith (1995), the Compustat items debt due in year one to five, DD
1to5
, appear to contain
erroneous data as the ratio of DD
1to5
to total debt is sometimes larger than one and sometimes below zero. We follow their
adjustment and require the ratio to lie between 10% and 110%. In case the ratio lies between 100% and 110%, we scale DD
1to5
down
by dividing it by the ratio itself. Observations outside of the acceptable range are ignored in the first step and then are assigned the
average value of T
LT
. Based on T
LT
, we obtain T as:
T T
LT
D
LT
D
0:5
D
ST
D
; A:7
where D
ST
is debt in current liabilities. Finally, for observations for which we were not able to compute a value, we set T to the
average T of the aggregate sample.
Based on T, we extract the risk-free rate r from interest rates on constant Treasury securities. To do so, we first construct yield
curves using cubic spline interpolation for each event date in our sample and then obtain r as the risk-free rate observed on that
date for maturity T.
Finally, we back out an estimate of asset value V from equity values assuming that the relation between equity value and firm
value is correctly described by our pricing framework. Observing the value of equity and given all other pricing parameters except
V, we can compute V numerically such that it solves Eq. (2).
15
Relative to the measure used in Eom et al. (2004) and Bharath and
Shumway (2008), who set V equals to the market value of equity plus the book value of total debt, this yields more realistic values
of V for firms closer to financial distress: Book values of debt are a particularly poor (upward-biased) proxy of the market value of
debt for these firms. As pointed out previously, the incentive to shift risk is particularly relevant for such firms. Overstating V by
overstating the value of debt would lead to a downward biased estimate of the value of risk-shifting. Calculating V as described
allows us to avoid this bias.
16
Appendix B. Analysis of announcement effects
Appendix B.1. Event date
The determination of the event date strictly follows the approach of Duca et al. (2012), who assume that the public
announcement of convertible debt offerings happens on the filing date obtained from SDC. In footnote 12, Duca et al. state that
they manually cross-check the accuracy of the filing dates by verifying the actual announcement dates obtained from Factiva for
100 convertible bond issues. The researchers find that the SDC and Factiva dates are identical for all 100 issues. Because their
sample (January 1984 to December 2009) is almost the same as ours (January 1984 to December 2010), we rely on the same
assumption.
As mentioned by Duca et al. (2012), the filing date is, however, only available for publicly placed convertible bond issues. In
their sample, 754 of the 1436 convertible debt issues were not publicly placed, which is consistent with the 50% proportion of our
convertible issues for which SDC does not report a filing date. For the remainder of the convertibles, we manually look up the
announcement date in Factiva, as suggested by Duca et al. (2012).
15
This is comparable to computing implied option volatilities when all other pricing parameters and the price of an option are observed.
16
On average, our estimates of V are 9.77% below the book value-based estimates.
For 50 randomly picked post-1996 issues, we double-check the announcement date obtained from Factiva by looking for the
earliest corresponding form on the SEC's EDGAR system.
17
For five of these private issues, we cannot find a corresponding report
on EDGAR. For 43 issues, using EDGAR would have led to the exact same date as using Factiva. For the two remaining issues, the
issue date in Factiva is one or two days earlier than the date in EDGAR.
Appendix B.2. Credit spread data
Our initial sample is identical to the main sample of 1229 convertible debt announcements we use in the study of equity
returns. Using names and CUSIP identifiers of the convertible issuer, we match this dataset to the TRACE (Trade Reporting and
Compliance Engine) and the Mergent FISD (Fixed Income Securities Database) databases, from which we obtain trading data and
information about bond characteristics, respectively. In a first step, we match 868 of the events to issuers for which trading data
are reported in TRACE. In total, data for 2397 bonds from these issuers is available from both TRACE and FISD. For a large part of
these events, trading data is only available for convertible bonds. After discarding all 834 convertible debt issues, the number of
events for which bond data is reported in FISD and TRACE falls to 376. A large portion of the remaining bonds was inactive as of
the announcement date. That is, the remaining bonds either matured before the date or were issued afterwards. Dropping
inactive observations leaves bond observations for 182 announcements. Given that corporate bonds are traded infrequently, this
number falls further when we require the bonds to be traded during the event window, as described below.
Appendix B.3. Changes in credit spreads
In a first step, we calculate the yield spread for each bond trade by subtracting a maturity-matched, risk-free rate from the
yield reported in TRACE.
18
For each announcement date AD
i
, we then derive before- and after-announcement reference dates RD
as the dates for which trading data are reported in TRACE, and which are at least two, but no longer than five, days before or after
the announcement date. If trades are reported on multiple days before and after the announcement, we use the dates that are
closest to the announcement (but still not closer than two days). Thus, RD
before
= max(AD
i
b
i
) and RD
after
= min(AD
i
+ a
i
),
where b
i
and a
i
are between 2 and 5. This procedure yields an average event window of 5.46 days. Increasing the length of the
event window would increase the sample size, but would simultaneously yield more noisy estimates of announcement effects.
Finally, we define our measure of the announcement effect on credit spreads as
CS
i

1
N
i
N
i
j1
CS
i; j;after
CS
i; j;before
_ _
; B:1
where CS
i; j;before
and CS
i; j;after
are the average credit spreads of all trades on bond j reported by the issuing firm i for the RD
before
and
RD
after
. N
i
is the number of bond issues of firm i with available data.
Appendix C. Control variables
CD to Total Debt: Convertible debt scaled by total debt. The level of convertible debt is primarily based on Compustat itemDCVT.
For firms issuing convertibles more than once in the same fiscal period, we account for the potential impact of previous issues
on the capital structure of the firm. Total debt is the sum of long-term debt and debt in current liabilities (Compustat Items
(DLTT + DLC)).
Leverage: Total debt (Compustat items DLTT + DLC) scaled by the sum of total debt and the market value of equity (CRSP items
PRC SHROUT).
Log MB: The natural logarithm of the ratio of market and book value of equity, where market values are taken from CRSP and
the book value of equity equals Compustat item SEQADJ.
Stock Return Volatility: The annualized standard deviation of monthly stock returns reported in CRSP of up to 10 years before
the event. We require at least 12 months of data.
Nasdaq Listing: Dummy indicating Nasdaq listing. Equals one when Compustat item EXCHG is 14, and zero otherwise.
FirmSize: The natural logarithm of the sum of the market value of equity (CRSP items PRC SHROUT) and total debt (Compustat
items DLTT + DLC) in millions.
Tangibility: Plant property and equipment scaled by the book value of assets (Compustat items PPEGT/AT).
R&D Intensity: R&D expenditure scaled by sales (Compustat items XRD/SALE).
Amihud Liquidity: Average of the ratio of absolute daily returns and daily trading volume observed during 12 months. We
multiply the measure by 10
6
for displaying purposes and require at least three months of data.
17
As noted on EDGAR's website (http://www.sec.gov/edgar/aboutedgar.htm), Companies were phased in to EDGAR ling over a three-year period, ending May
6, 1996. As of that date, all public domestic companies were required to make their lings on EDGAR, except for lings made in paper because of a hardship
exemption.
18
We obtain the risk-free rate from Treasury yield curves constructed using cubic spline interpolation, in the same way we did in Subsection 3.3.1. The maturity
used to obtain the risk-free rate is equals to the time between the TRACE trading date and the bond maturity reported in FISD.
Dividend Paying: Dummy indicating whether a firm pays dividends. The dummy is set to one when Compustat item DVC is
above zero.
Dividend Paying: Dummy indicating whether a debt issue is made under Rule 144a.
Financial Distress: = TLMTA
NIMTAAVG
CASHMTA
+ MB
RSIZE
PRICE
EXRETAVG
+ SIGMA
. The variables
entering the calculation are identified by Campbell et al. (2008) as the most powerful predictors of corporate default.
Specifically, NIMTAAVG, TLMTA, and CASHMTA measure net income, liabilities and cash holdings relative to an estimate of the
market value of assets, respectively. EXRETAVG is the stock's 12 months excess return over the S&P500; SIGMA measures equity
volatility; RSIZE is the market value of equity relative to the total market value of the S&P500; MB is the market-to-book ratio,
and PRICE is the stock price truncated at 15. In line with citeCampbell-etal-2008, we winsorize all variables at the 5th and 95th
percentiles of their distribution. The star

indicates that we normalize each of the variables by subtracting their mean and
dividing by their standard deviation. For further details on the derivation of these variables, see Campbell et al. (2008).
Secured Debt: Secured long-term debt scaled by total long-term debt (Compustat item DM/DLTT).
Proceeds: Issue proceeds as reported in SDC Platinum scaled by the sum of total debt (Compustat items DLTT + DLC) and the
market value of equity (CRSP items PRC SHROUT).
Debt Maturity: Corresponds to the parameter T used to compute RSI and described previously.
Regulated Industries: Our sample of firms in regulated industries includes all firms with an SIC code from 4810 to 4899, 4910 to
4924, and 4930 to 4941.
CEO Ownership: Number of shares owned by the CEO scaled by total shares outstanding. Obtained directly from the Compustat
ExecuComp database (item SHROWNEXCLOPTSPCT).
SP500 Return: Return on the S&P 500 index over a 12-month window. Obtained from CRSP.
Interest Rate: Interest rate on 10-year constant maturity Treasuries. Obtained from the Federal Reserve Bank reports.
Baa Credit Spread: Average Moody's Baa corporate bond yield minus the yield on 10-year constant maturity Treasuries.
Obtained from the Federal Reserve Bank reports.
Leading Indicator: Conference Board Leading Economic Indicator obtained from Datastream. It is computed from the following
components: the average weekly hours worked by manufacturing workers, the average number of initial applications for
unemployment insurance, the amount of manufacturers' new orders for consumer goods and materials, the speed of delivery of
newmerchandise to vendors fromsuppliers, the amount of neworders for capital goods (excluding aircraft orders), the amount
of new building permits for residential buildings, the S&P 500 stock index, a credit index, consumer sentiment, and the spread
between long and short interest rates.
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